While designed to achieve certain goals, Canada’s progressive tax system can lead to inefficiencies for couples with significantly different incomes. As retirees, it’s essential to explore tax-reduction strategies to maximize your family’s financial efficiency. Techniques such as “pension income splitting” and “pension sharing” can significantly impact your overall tax liability and leave more money in your pocket to achieve your family’s goals.
Pension Income Splitting:
Retirees can employ pension income splitting, allowing them to allocate up to 50% of their eligible pension income to their spouse or common-law partner. This includes any pension income that qualifies for the $2,000 federal pension income credit. Notably, income received from Registered Pension Plans (RPPs) such as defined benefit (DB) or defined contribution (DC) pension plans can be split with your spouse before age 65. For couples over 65, withdrawals from their Registered Retirement Income Fund (RRIF) or Life Income Fund (LIF) can be split with their spouse, even if the receiving spouse is not over 65. However, it’s essential to remember that RRSP withdrawals do not qualify as pension income for splitting purposes.
While Canada Pension Plan (CPP) payments do not qualify as pension income for splitting, sharing this income with your spouse is still an option. Spouses and common-law partners of at least 60 can share up to half of their CPP retirement benefit. The sharing amount is determined based on the years lived together during the period contributions were made to CPP. Unlike pension income splitting, the election to pension share only needs to be made once, and each spouse will receive a monthly payment for the shared amount. A CPP pension sharing form must be completed and submitted to Service Canada to initiate pension sharing.
Beyond the evident advantage of taxing a portion of the family’s income by the lower-income earner, proper income planning can yield additional benefits. One such benefit is related to the Old Age Security (OAS) recovery tax, commonly known as the clawback. The OAS clawback applies when a taxpayer’s net income surpasses the threshold determined by the Canada Revenue Agency (CRA). For 2023, the minimum threshold is $86,912, increasing to a maximum of $141,917 for individuals aged 65-74 and $147,418 for those aged 75 and above.
The OAS benefit is reduced by fifteen cents for every dollar of net income exceeding the minimum threshold, and it’s fully clawed back once net income reaches the maximum. Retirees may effectively reduce their net income by transferring pension income to a lower-income spouse or common-law partner’s tax return, potentially saving them from the OAS clawback and retaining their OAS payments.
Income splitting strategies such as pension income splitting and pension sharing can be powerful tools for retirees seeking to optimize their tax situation and maximize their disposable income. By taking advantage of these opportunities, couples with lopsided incomes can work towards achieving their family’s financial goals more efficiently. Additionally, careful income planning can yield further benefits, such as mitigating the impact of the OAS clawback. Retirees must seek professional financial advice tailored to their unique circumstances and goals to make the most of these strategies.